Taxation Of World Cup Players

 

I was reading a U.S. Representative criticizing the taxation of FIFA winnings:

We want to encourage these people to come over here and spend their money, and then we take a big chunk of it.”

I get it, but I would like to hear more about taking a big chunk of residents’ money before overly concerning ourselves with nonresidents.

Let’s take a (very) general walkthrough of the taxation of FIFA players.

Resident versus Nonresident

A resident of the U.S. is taxed on worldwide income. It doesn’t matter whether you work in the U.S.; in fact, it doesn’t matter if you live in the U.S. If you are a resident, you are subject to U.S. tax.

The easiest way to be a resident is to be born here. There are special rules for U.S. births who did not grow up here, but we will leave that issue alone.

The next way is to obtain a green card, which requires one to go through the immigration system.

A third way is to spend too much time here – which the tax Code terms “substantial presence.” There is math involved, as follows:

·      Present in the US for at least 31 days during the calendar year, AND

·      Present in the US for at least 183 days during the current and preceding two years. Days in the preceding year count at a 1/3 rate; days in the second preceding year count at a 1/6 rate.

Have a German company send an employee to a U.S. office for two or three years and he/she will likely meet the substantial presence test. He or she is not a U.S. citizen but is a U.S. resident under the substantial presence test.

It is unlikely that a FIFA player is going to trip the substantial presence test.

Meaning the FIFA player is a nonresident.

And his/her income taxation changes. The player is now concerned only with U.S.-source income.

One can get mystical when talking about U.S. source.

Does a Swede receiving interest from loaning money to a U.S. business have U.S.-source income?

Does a Brazilian receiving dividends from a multinational corporation have U.S.-source income?

We leave the mystical and return to the concrete when discussing services: if you perform services here – say a player in the World Cup - you will have U.S.-source income.

Divide U.S.-Source Income into Categories

There are two main categories of U.S.-source income, and they are critical in understanding nonresident taxation.

Effectively Connected Income

There should be a trade or business as a first step if we want ECI. It can be humble – a restaurant, dry cleaner or liquor store – but there has to be enough regular and continuous activity to rise to the level of a trade or business. That trade or business activity in turn must take place within the U.S. Meet both criteria and you have ECI.

BTW compensation for the performance of services within the U.S. - like playing soccer - is normally considered ECI.

Fixed, Determinable, Annual, or Periodical (FDAP) Income

The easy definition is any income that is not ECI.

Examples would include interest, dividends and royalties.

Think of FDAP as investment income – not trade or business income – and you get the idea. In days past it would have been a check that arrived in your mailbox.

Allocating Compensation to the U.S.

Only compensation earned while in the U.S. will be subject to U.S. taxation. Sounds fair, but translating that concept to actual numbers can be tricky.

Here is one suggestion: divide the numbers of days in the U.S. by 365 days.

Problem: athletes have seasons. They are not office workers with 9 to 5s and two weeks annual vacation. Using 365 as a denominator does not seem to fit our FIFA discussion.

How about using the number of games as the denominator?

Better, but what about team meetings, practices, press conferences, mandatory league events? Should we include those days in the denominator?

Seems right.

How about bonuses?

There is a can of worms.

This concept BTW is sometimes referred to as “duty days.”

The point is to come up with a ratio, with U.S. duty days as the numerator and total duty days as the denominator.

Allocating Noncompensation to the U.S.

We are talking name/image/likeness, endorsements and things related. Chances are these payments are referred to as royalties.

How are we supposed to reasonably allocate this to the U.S.? Lionel Messi and Cristino Ronaldo are already famous and earning their NILs and endorsements without entering the U.S. I could argue that a reasonable allocation to the U.S. would be zero (-0-).

If there was a product endorsement, a reasonable allocation might include dividing the amount of product sold in the U.S. by total product sold worldwide.

I am not as sure what to do with indirect endorsements, such as wearing Nike products on a regular basis.

Yep, room here for disagreement.

Tax Deductions

There is a significant difference between the taxation of ECI and FDAP income:

You are allowed to deduct expenses against ECI.

You are not allowed to deduct expenses against FDAP.

And you can immediately see the tax planning: move income between ECI and FDAP as necessary and as possible.

Withholding

You may have read that the IRS was taking 30% off the top of FIFA winnings.

True but misleading.

The 30% was withholding.

The player still has to file a nonresident tax return.

Granted, the default rate for FDAP income is 30%, so that income bucket might be a push.

But ECI allows for deductions and graduated tax rates.

Depending upon the amount of deductions and his/her run through the tax rates, that 30% withholding might be excessive. The player might be entitled to a refund.

I doubt that FIFA players would have much in the way of deductions, however, as I expect the club to absorb team and travel expenses.

Filing the Tax Return

Nonresident aliens have their own tax form:

If the athlete received a W-2, it would go on line 1a.

If the athlete was self-employed, the net business income would go first on Schedule 1 and then on line 8.

Line 9 is the sum of all income in the ECI bucket.

NOTE: Nonresident aliens are normally not subject to self-employment tax.

What about FDAP income?

It has its own schedule.

Tax Treaties

Treaties can override what we just discussed above.

Let’s look at an example.

Sergio Garcia was a professional golfer and party to a famous tax case involving services, FDAP and a treaty. It goes without saying that the IRS and Garcia did not agree on how to allocate U.S.-source income. The Tax Court finally decided that the NIL/endorsement/whatever-you-want-to-call-it was not so intertwined with his performance of services as to require it to be allocated the same as compensation for services. The Court said that 35% were for services and 65% were royalties.

So what, you ask.

Garcia was a resident of Switzerland.

Switzerland has a tax treaty with the U.S.

Which includes the following language:

Royalties derived and beneficially owned by a resident of a Contracting State shall be taxable only in that State.”

“Contracting State” is a common term in tax treaties.

Garcia was a resident of Switzerland which in turn was a Contracting State meaning that royalties received by Garcia were taxable only to Switzerland.

That 65% representing royalties was not taxable by the U.S.

You see the power of a treaty.

Central Withholding Agreement

This is a way to negotiate with the IRS to lower the 30% withholding rate for personal services (such as a nonresident athlete or performing artist).

The IRS has a specialized unit for this work, and - not surprisingly - there are fairly strict timelines for request and approval.

State and Local Income Taxes

We are talking about the jock tax.

Most states use some version of “duty days” that we discussed above. California famously counts every practice held at an opponent’s facilities during a game week. The point, of course, is to increase the numerator (that is, the duty days allocated to California).

Certain cities will also pile on, for example:

New York City                 3.8% tax rate

Philadelphia                     3.4% tax rate

Cleveland                         2.5% tax rate

Mind you, this is on top of the state tax.

And tax treaties do not apply to state and local taxes.

Spain

What is Spain’s equivalent to the U.S. tax regime?

Well, the automatic withholding is less: 24% (reduced further to 19% for a resident of another EU country).

The top tax rate will hurt, though. The maximum national rate tops out at 47%, with certain regional authorities increasing it to 54%.

The maximum U.S. tax rate by contrast is 37 percent.

Retirement Assets In A CDP Hearing

 

Let’s talk about a Collection Due Process (CDP) hearing, how CDPs came about and a great way to flub one.

Think of filing taxes as having two phases:

·      The assessment of tax

 For most of us, this means filing the return. It shows total tax due, from which is subtracted tax withholdings and other payments. In general, processing the return is tantamount to assessing the total tax due shown on the return. Assessment in turn begins the statute of limitations. 

·      The collection of tax 

If you are overpaid, you are normally done with the process right here. 

Go the other way and the IRS may send notice and demand for payment. If the taxpayer fails to pay, a tax lien is created automatically retroactive to the date of assessment (Sec. 6321). 

This lien is a quiet lien and does not take priority over other competing claims. The lien we fear - the publicly-recorded lien which does take priority – requires a second step. 

The lien establishes a pathway for the IRS to take property to satisfy that unpaid assessment. The IRS could, for example, bring suit to enforce the lien. More commonly, the IRS will take collection action without seeking court approval. 

That ability to take property – a bank account, a garnishment on a paycheck – is generally referred to as a power to levy.

The CDP hearing takes place here – at the point where the IRS wants to formally file its lien and/or engage its Collection division.  Code section 6330 provides for CDP hearings. Congress wanted to protect taxpayers from arbitrary or abusive IRS actions (there was history) as well as provide procedural guardrails for taxpayers.

Section 6330 requires the IRS to notify a taxpayer at least 30 days in advance of his/her right to an administrative hearing (the CDP hearing) before the IRS Office of Appeals. After the Office issues its determination, the taxpayer may then petition the Tax Court for judicial review. This review is very limited and concerns abuse of discretion by the IRS.

It may come as a surprise to a nonpractitioner, but a taxpayer is generally not allowed to dispute a tax liability at a CDP hearing. The reasoning is that the taxpayer had earlier opportunities to dispute a liability. The CDP is instead a collection hearing. To the extent review of an underlying liability is permitted, it is as a remedy against abusive collection and as protection for taxpayers who would fall through the cracks (for example, a taxpayer who was never notified that they were in Collections).

Let’s talk about a CDP case in Scanlon and Fairweather v Commissioner.

“The only issue for decision is whether the Internal Revenue Service (IRS) Office of Appeals (Appeals) abused its discretion in sustaining” collection actions against the taxpayers.

The Court’s involvement is limited: it will not reopen the matter (nerd term is “de novo”), but it will review to determine if the IRS abused its authority, perhaps by not following its own rules. This limit is intentional. CDP cases constitute approximately 15% of Tax Court cases annually, even with this limited reach.

Lawrence Scanlon was an associate professor of English at Rutgers University, and his wife (Aline Fairweather) was an attorney with Pepper Hamilton. For the years 2011 through 2013 their taxable income ranged from $345,603 to $441,185. The tax issue was their failure to pay estimated taxes against that income, resulting in a considerable tax bill.

Here is a timeline:

10/21/14      IRS sent Notice of Federal Tax Lien for 2011 and 2012.

11/27/14        Taxpayers sent Form 12153 (Request for CDP or Equivalent Hearing). Taxpayers did not challenge the underlying liabilities.

1/12/15        IRS Settlement Officer (SO) requested financial information (Form 433-A), collection alternatives, a copy of the 2013 return, and a scheduled follow-up call for 2/4/15.

1/13/15        IRS sent a second lien notice for 2013.

1/31/15        Taxpayers’ representative (Markham) sent the SO Form 433-A and proposed monthly payments of $3,000.

2/4/15          The SO tried but failed to contact Markham.

2/4/15          Later that day Markham faxed the SO saying that a follow-up was not necessary, that taxpayers had submitted financial information, and reiterated the monthly $3,000 proposal.

2/10/15        IRS sent Final Notice of Intent to Levy for 2013, which liability exceeded $117 grand.

2/20/15        Taxpayers submitted another 12153 (for a second CDP hearing). Taxpayers also resubmitted the 433-A from 1/31/15 proposing a monthly $3,000 payment.

3/16/15        The SO determined that taxpayers had enough retirement assets (one account at TIAA-CREF and a second at Vanguard, both totaling $645,538) to pay the IRS ($271,941) and scheduled a telephone conference for 7/24/15.

7/24/15        Taxpayers objected to the retirement proposal, arguing tax implications. The SO had another call. She was to return the call by end of day, but she could not reach Markham. The SO scheduled another conference call for 9/23/15.

9/23/15        Markham told the SO that taxpayers could not reach the retirement funds; the SO asked how Mrs Fairweather had managed to borrow $30,000 against her Vanguard account. The SO wanted some verification that no further borrowings or withdrawals were available from Vanguard or TIAA-CREF. She requested a response date of 9/30/15.

11/20/15      Taxpayers had not responded. The SO checked 2014 (not enough tax payments to cover the liability) and 2015 (no payments at all). She left a message for taxpayers that she was proceeding with collection action.

And … we are in Tax Court.

I could predict how this would go when I got to 7/24/15.

Through that date, the SO was behaving with restraint. The taxpayers were repeating a pattern (not paying) and the taxes due were adding up. The taxpayers however appeared to be acting in good faith, even though one had to wonder where the household income was going.  

Then we reached the two retirement accounts. Mrs Fairweather argued that one (Vanguard) was beyond her reach. We know next to nothing about the second. We do know that Markham (taxpayers’ representative) objected “because of its tax implications.” Really? If you are this deep into IRS machinery, I doubt the SO is overly concerned about your tax implications. I might, if pressed, request the SO to allow withdrawal and payment over two calendar years - to lessen some of the tax pressure.

And here is decades of tax practice speaking: you cannot - CANNOT - blow-off a response date. If there is a problem obtaining paperwork, let the IRS know as soon as possible. If life makes you unavailable that day, have someone in the office contact the IRS, preferably ahead of any scheduled call. There are … companies … out there that will use CDPs (and similar) to delay and obstruct collection activity. I know this. The IRS knows this. Do NOT give the SO reason to think you are one of those people. 

NOTE:  I have found that failure to make current estimated tax payments will generally doom a taxpayer’s request for a payment plan. I understand the issue: how can I pay this year when I cannot afford to pay the back years? Pay something toward the current year. Extend the return and continue paying on the year until you file on the last day of extension. Cut out some expenses and redirect the money. The IRS wants to see you stop digging the hole you are in.

Here is the Court:

Petitioners do not challenge the validity of their underlying Federal income tax liabilities for 2011, 2012, and 2013."

As discussed, a CDP is not the place for this anyway.

… petitioner’s underlying liabilities are not properly before the Court, and we will review Appeal’s determination for abuse of discretion…”

We do not conduct an independent review and substitute our own judgement for that of the appeals officer.”

What is the Court going to look at?

The only issue petitioners raise is whether Appeals determination to reject their proposed installment agreement and sustain the lien filings for 2011, 2012, and 2013, and the proposed levy for 2013 was an abuse of discretion.”

The first issue is the failure to make current estimated tax payments.

But …

No surprise. I have butted heads here too many times to count.

The second issue involves burning the retirement account(s).

I see that Mr Scanlon was 60 years old and Mrs Fairweather was 55. How about an economic hardship argument - only so many years to restore the monies otherwise drained from the retirement account and such?

Here you see an instance of hard procedure. There are areas in tax where “turn right” is not the same as “turn left, then left, then left.” This is one of them.

The IRS won. The IRS almost always wins a CDP case. The Court is reviewing for abuse of discretion and not for commendable application of common sense. It is a very high bar to overcome.

Our case this time was Scanlon and Fairweather v Commissioner, T.C. Memo 2018-51.

Odd Reason To Be In Tax Court

 

Not all accountants practice tax.

To the contrary, I suspect most accountants do not. The confusion, I suspect, has to do with the CPA license. One associates the license with practicing at a CPA firm, but that is not necessarily true. Most accountants do not practice at a firm, and just practicing at a firm does not mean that one works tax. I have worked with a firm my entire career, and there have been many CPAs – auditors, forensics, valuation experts and so on – who have little crossover with tax. Step outside a firm – say internal audit or accounting at a corporate employer – and those numbers only increase.

I am looking at a pro se case in the Tax Court.

We have discussed pro se many times. It is commonly described as a taxpayer representing himself/herself before the Court. That technically is not true. A taxpayer can have professional representation and still be considered pro se. What it means is that the representative does not have a license to independently practice before the Court. The representative can act as an agent, advocating for and advising a taxpayer, but without that license the taxpayer is still considered pro se.

That license requires one to pass an exam, and the Tax Court exam is commonly considered one of the more challenging exams in tax practice. The exam BTW is not about tax law; rather it is about rules and procedures at the Tax Court. I have been involved in this area for decades, and I admit that those rules and procedures can be a bit … arcane.

Eva Zaczek finds herself in Tax Court. There is only one issue: how much does she owe? The answer in turn depends on how much of her Affordable Care (that is, Obamacare) subsidy was overpaid and now has to be returned. The concept is straightforward: make little money and the subsidy might fully pay for the premiums; make too much money and there is no subsidy at all. The rub is that someone is applying for the subsidy early in the tax year, before knowing what income for the year will be. Take a promotion or job change or marriage – or just ignore the too-much-income issue altogether - and the numbers can swing hard.

The IRS sent Eva a Notice of Deficiency for $2,418.

COMMENT: Eva sent a handwritten tax return, and the IRS made mistakes reading her writing.  

To its credit, the IRS admitted its mistake and revised the balance due to $900.

Eva challenged the calculation.

The rub was line 11 of Form 8962 Premium Tax Credit.

Both Eva and the IRS agreed that the number in box 11(b) should be $7,294.

This box represents the maximum premium that can be subsidized.

Both agreed that box 11(c) should be $9,057.

This amount represents the amount of premium the taxpayer is expected to pay himself/herself, without subsidy.

Eva calculated box 11(d) as $1,763 ($9,057 - $7,294).

Eva got the numbers reversed. Box 11(d) should be minus $1,763 ($7,294 - $9,057).

So?

If you read the instructions, box 11(d) cannot go below zero ($-0-).

Eva was convinced she owed the IRS $1,763.

The IRS said no, no: you only owe us $900.

And Eva was in Court arguing that she owed the $1,763 and not the $900 the IRS was seeking.

Here is the Court:

      

I will spare both of us the difference in tax law between a “deficiency” and a “balance due,” other than to point out the IRS notice that got Eva into Tax Court is called a Notice of Deficiency.

Pro se cases have a reputation for being entertaining, and we have looked at a number of them over the years.

But to go to Tax Court to argue that one owes more than the IRS wants? And this action from an accountant?

I consider this to be shade: 

I truly, truly hope that Eva doesn’t practice anywhere near a tax return.

This time we talked about Eva Zaczek v Commissioner, docket 4667-25S, filed 7/15/26.